Recent legislation imposes new compliance and tax burdens on individuals with foreign connections.

• Author: Lifson, David A.

During the summer of 1996, two of the four bills enacted with tax provisions contained substantial changes to the Federal tax treatment of US. individuals and trusts with foreign connections. The Small Business Job Protection Act of 1996 (SBJPA) is principally economic and tax policy legislation, while the Health Insurance Portability and Accountability Act of 1996 (HIPAA) is generally social policy legislation that contains certain tax provisions to "finance" targeted policy objectives. This summer's legislation produced a comprehensive change to the Federal tax system. Many of the provisions will undoubtedly affect taxpayers in numerous (and perhaps unexpected) ways. Individuals with certain existing or planned foreign connections or transactions are particularly affected, because Congress used as revenue raisers several "off the shelf" provisions that had been considered for years.

Increasing Compliance

Various new compliance features have been added to the tax system, including:

* Annual reporting of foreign gifts. * Enhanced reporting responsibilities for foreign trusts and their beneficiaries. * Penalties for noncompliant U.S. persons involved with trusts. * Departure and post-departure reporting obligations for expatriating citizens and departing long-term aliens. * A future study to improve tax compliance.

Gift Reporting

SBJPA Section 1905 (a) imposes a new reporting requirement, Sec. 6039F, on U.S. persons receiving gifts or bequests from foreign persons during the year totaling, in the aggregate, more than $10,000.(1) According to SBJPA Section 1905(c), this provision is effective for gifts and bequests received after Aug. 20, 1996, and is a change in reporting only. Gifts by foreign persons to U.S. persons of tangible personal property located outside the US. and intangible property wherever situated are still not subject to Federal gift tax. Because the IRS has yet to prescribe the information that needs to be provided with respect to such foreign gifts, there is no current requirement to report them, but any regulations will probably require retroactive reporting to Aug. 20, 1996. A failure to file such information without reasonable cause authorizes the IRS to determine the tax treatment of foreign gifts. Judicial review of any such determination will be overturned only if the determination is "arbitrary or capricious," a very difficult standard to satisfy.(2) In addition, the U.S. person is subject to a penalty under Sec. 6039F(c) of 5% of the amount of such gift for each month for which the failure continues (up to a maximum of 25%).

Foreign Trust Reporting

Foreign trusts are now subject to several enhanced reporting requirements. The creation of, or the transfer (directly or indirectly) of money or other property to, a foreign trust by a U.S. person must be reported within 90 days. While this reporting requirement is not new,(3) the severe new penalties enacted will aid enforcement efforts.

SBJPA Section 1901(a) amended Sec. 6048(c) to require that a U.S. person who receives (directly or indirectly) after Aug. 20, 1996 any distribution from a foreign trust must report the name of the trust, the aggregate amount of distributions received for the tax year and any other information the IRS may prescribe.

Grantors are also subject to increased compliance burdens. Under Sec. 6048(b)(1), as amended, a U.S. person treated under the grantor trust rules as the owner of any portion of a foreign trust is responsible for ensuring that the trust (1) files a return containing a full and complete accounting of trust activities for the year, the name of its U.S. agent and any other information the IRS prescribes and (2) furnishes information to be prescribed by the IRS to each U.S. person treated as a trust owner or who receives (directly or indirectly) a trust distribution.

The enhanced beneficiary and grantor reporting provisions apply to tax years of U.S. persons beginning after 1995, and should increase the IRS's ability to collect taxes from U.S. persons receiving benefits from foreign trusts.

Enforcement Mechanisms

Important new measures enhancing the enforcement of these provisions add tax traps for the unwary. Sec. 6048(b)(2) provides that if a U.S. person is treated as the owner of a foreign trust, a U.S. person must be authorized as a limited agent of such trust to accept (1) service of process with respect to IRS requests to examine records or take testimony and (2) a summons (subpoena) for such records or testimony...